DETERMINING THE FACTORS THAT LIMIT AGRO-PROCESSING DEVELOPMENT IN THE WHEAT MILLING AND BAKING INDUSTRIES IN RURAL AREAS IN SOUTH AFRICA By André Louw, Mariëtte Geyser & Jacques Schoeman i Disclaimer “Information contained in this document results from research funded wholly or in part by the NAMC acting in good faith. Opinions and points of view expressed herein do not necessarily reflect the official position or policies of the NAMC. The NAMC makes no claims, promises, or guarantees about the accuracy, completeness, or adequacy of the contents of this document and expressly disclaims liability for errors and omissions in the contents hereof. 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Reference made to any specific product, process, service by trade name, trade mark, manufacturer or any other commercial commodity or entity are presented for informational purposes only and do not constitute or imply approval, endorsement or favouring by the NAMC.” ii NATIONAL AGRICULTURAL MARKETING COUNCIL DETERMINING THE FACTORS THAT LIMIT AGRO-PROCESSING DEVELOPMENT IN THE WHEAT MILLING AND BAKING INDUSTRIES IN RURAL AREAS IN SOUTH AFRICA NAMC Report by Andre Louw , Mariëtte Geyser & Gerhard Troskie August 2010 Department of Agricultural Economics, Extension, and Rural Development Absa Chair in Agribusiness Faculty of Natural and Agricultural Sciences University of Pretoria iii Sectional inputs were contributed by Melissa van der Merwe Richard Nicholson Nico Scheltema Almarie Nordier Special appreciation for inputs from the following organisational in the respective industries Jannie de Villiers, CEO of the National Chamber of Milling All individual bakers and millers who participated and Andre van der Vyver (Dr), Director of UT Grain Management (Pty) Ltd & Senior Lecturer at the University of Pretoria iv TABLE OF CONTENTS LIST OF FIGURES ...................................................................................................................................vii LIST OF TABLES ......................................................................................................................................ix EXECUTIVE SUMMARY ........................................................................................................................... x CHAPTER 1 STUDY OBJECTIVES, DATA COLLECTIONS AND METHODOLOGIES .......................... 1 1.1 STUDY OBJECTIVES .................................................................................................................. 1 1.2 DATA COLLECTION .................................................................................................................... 2 1.3 METHODOLOGIES USED BY THE STUDY ................................................................................ 3 1.3.1 STRUCTURE, CONDUCT AND PERFORMANCE FRAMEWORK ....................................... 3 1.3.2 PRICE VOLATILITY .............................................................................................................. 5 1.3.3 RISK MANAGEMENT ANALYSIS ......................................................................................... 6 CHAPTER 2 WHEAT LITERATURE REVIEW ......................................................................................... 8 2.1 INTERNATIONAL LITERATURE STUDY .................................................................................... 8 2.2 SOUTHERN AFRICAN DEVELOPMENT COMMUNITY (SADC) .............................................. 13 2.3 SOUTH AFRICA LITERATURE REVIEW .................................................................................. 13 2.4 CONCLUSIONS ......................................................................................................................... 26 Chapter 3 MARKET OVERVIEW .........................................................................................................27 3.1 GLOBAL WHEAT OVERVIEW .................................................................................................. 27 3.1.1 STOCK LEVELS .................................................................................................................. 28 3.1.2 PRODUCTION LEVELS ...................................................................................................... 29 3.1.3 CONSUMPTION LEVELS ................................................................................................... 32 3.1.4 INTERNATIONAL TRADE ................................................................................................... 33 3.1.5 PRICE AND PRICE CYCLES .............................................................................................. 38 3.1.6 THE WHEAT MILLING INDUSTRY ..................................................................................... 40 3.1.7 CURRENT ISSUES AND CHALLENGES ........................................................................... 41 3.2 SOUTHERN AFRICAN DEVELOPMENT COMMUNITY (SADC) OVERVIEW .......................... 43 3.2.1 PRODUCTION LEVELS ...................................................................................................... 43 3.2.2 CONSUMPTION LEVELS ................................................................................................... 44 3.2.3 STOCK LEVELS .................................................................................................................. 44 3.2.4 IMPORT AND EXPORT LEVELS ........................................................................................ 45 3.2.5 PRICES AND PRICE CYCLES ............................................................................................ 47 3.2.6 FOOD SECURITY ................................................................................................................ 48 3.2.7 CURRENT CHALLENGES AND ISSUES ........................................................................... 50 3.2.8 MILLING INDUSTRY ........................................................................................................... 50 3.3 SOUTH AFRICAN OVERVIEW .................................................................................................. 51 3.3.1 STOCK LEVELS .................................................................................................................. 51 3.3.2 PRODUCTION LEVELS ...................................................................................................... 52 3.3.3 CONSUMPTION LEVELS ................................................................................................... 57 3.3.4 IMPORT AND EXPORT LEVELS ........................................................................................ 59 3.3.5 PRICE VOLATILITY ............................................................................................................ 66 3.3.6 RELATIONSHIP BETWEEN PRICE VOLATILITY AND RISK ............................................ 69 3.3.7 PRICE AND PRICE CYCLES .............................................................................................. 72 3.3.8 THE SOUTH AFRICAN WHEAT SUPPLY CHAIN .............................................................. 74 3.3.9 FOOD SECURITY ................................................................................................................ 79 3.3.10 MILLING AND BAKING INDUSTRY ................................................................................... 80 3.4 PORTER ANALYSIS OF THE WHEAT PROCESSING INDUSTRY .......................................... 83 3.5 CURRENT GLOBAL CHALLENGES FACED BY THE WHEAT INDUSTRY ............................ 88 3.6 CURRENT ISSUES IN THE GLOBAL WHEAT INDUSTRY ...................................................... 93 3.7 BUSINESS MODELS OF THE FUTURE .................................................................................... 94 3.8 THE ROLE OF THE COMPETITION COMMISSION ............................................................... 100 CHAPTER 4 DATA ANALYSIS AND RESULTS ...................................................................................102 v 4.1 INTRODUCTION ...................................................................................................................... 102 4.2 STRUCTURE OF THE INTERVIEWS ...................................................................................... 102 4.2.1 STRUCTURE OF WHEAT MILLERS INTERVIEWED ....................................................... 102 4.2.2 STRUCTURE OF BAKERS INTERVIEWED ..................................................................... 104 4.3 CONDUCT OF WHEAT MILLERS AND BAKERS INTERVIEWED ......................................... 106 4.3.1 INTRODUCTION ................................................................................................................ 106 4.3.2 LEVEL OF COMPETITION IN WHEAT MILLING AND BAKING ...................................... 106 4.3.3 STRENGTHS, WEAKNESSES, OPPORTUNITIES AND THREATS (SWOT) ....................... ANALYSIS ......................................................................................................................... 109 4.3.4 CRITICAL AREAS OF A WHEAT MILLING AND BAKING BUSINESS ........................... 117 4.3.5 THE KEY ISSUES/ CONSTRAINTS/ CHALLENGES CURRENTLY BEING EXPERIENCED BY WHEAT MILLERS AND BAKERS ............................................................................... 120 4.3.6 BARRIERS TO ENTRY AND EXIT OF WHEAT MILLERS AND BAKERS ...................... 122 4.3.7 PROCUREMENT DECISION ............................................................................................. 125 4.3.8 IMPORTS, EXPORTS OF WHEAT PRODUCTS ............................................................... 128 4.3.9 RISK MANAGEMENT ........................................................................................................ 129 4.3.10 LEGAL FRAMEWORK IMPACTING THE WHEAT MILLING AND ........................................ BAKING INDUSTRY .......................................................................................................... 135 4.3.11 SUPPORT STRUCTURES OF THE GOVERNMENT AND DTI ........................................ 138 4.4 PERFORMANCE OF WHEAT MILLERS AND BAKERS ........................................................ 138 4.4.1 FINANCIAL PERFORMANCE OF WHEAT MILLERS AND BAKERS .............................. 138 4.4.2 THE IMPACT OF INCREASES IN INPUT COSTS ON WHEAT MILLERS AND BAKERS140 REFERENCES: ......................................................................................................................................149 vi LIST OF FIGURES Figure 1: An illustration of the S-C-P paradigm ........................................................................................... 4 Figure 2: Deterministic S-C-P mode ............................................................................................................ 5 Figure 3: Dynamic S-C-P model .................................................................................................................. 5 Figure 4: Graphical representation of the risk management process. ......................................................... 7 Figure 5: Industries that are easy to enter but difficult to exit. .....................................................................10 Figure 6: Industries that are difficult to enter and easy to exit. ....................................................................11 Figure 7: Industries that are easy to enter and easy to exit. .......................................................................11 Figure 8: Industries that are difficult to enter and difficult to exit. ................................................................12 Figure 9: Wheat industry value chain .........................................................................................................15 Figure 10: Annual wheat milled in tons .........................................................................................................17 Figure 11: Market share of top wheat milling companies ..............................................................................19 Figure 12: Porters five forces for the milling industry as identified by the IDC (2010) ...................................26 Figure 13: World wheat ending stocks, 1960-2010 .......................................................................................28 Figure 14: Top five International Wheat Producing Areas based on acreage produced (2010) ....................29 Figure 15: Top five International Wheat Producing Areas based on bushels produced (2010) ....................30 Figure 16: Global Wheat Yields from 1960 to 2009 ......................................................................................31 Figure 17: US Wheat Production from 1960 to 2010 ....................................................................................31 Figure 18: Global Feed Usage in Million Metric tons from 1960 to 2010 ......................................................32 Figure 19: Domestic Usage of Global Wheat from 1960 to 2010 ..................................................................33 Figure 20: Top ten world wheat importers in percentage in 2008/2009 ........................................................34 Figure 21: World Wheat Exports (million bu) from 1960 to 2010 ..................................................................36 Figure 22: Market share of major wheat exporters (1991/92 – 2008/2009) ..................................................37 Figure 23: World wheat trade and US exports from 1991 to 2010 ................................................................38 Figure 24: International FOB US hard red wheat and Argentinean wheat prices from 04/01/2008 to 16/04/2010 ..................................................................................................................................39 Figure 25: Wheat milling process .................................................................................................................40 Figure 26: Section through a grain of wheat .................................................................................................41 Figure 27: Total SADC Wheat production from 1990 to 2009 .......................................................................43 Figure 28: Total SADC consumption from 1990 to 2009 ..............................................................................44 Figure 29: Wheat Grain Prices on the South African Futures Exchange (SAFEX) .......................................47 Figure 30: Import and Export Parity levels for South Africa from 2000 to 2010 ............................................48 Figure 31: South African Wheat, flour and bread prices ...............................................................................49 Figure 32: The contribution of each province in RSA to area wheat planted ................................................53 Figure 33: The contribution of each province in South Africa to wheat production .......................................54 Figure 34: The total area planted for wheat in RSA, the total production and average yield per hectare for the period of 1990 to 2010 * ........................................................................................................56 Figure 35: Wheat production and utilisation in South Africa for 2006 to 2014 ..............................................58 Figure 36: Wheat consumption for South Africa (2001 – 2010*) ...................................................................59 Figure 37: Wheat imports and exports of South Africa for 2006 – 2014 .......................................................60 Figure 38: Wheat SAFEX price with import and export parities at Randfontein from 2000 to 2010 ..............65 Figure 39: Wheat spot prices, Jan 2008-May 2010 ......................................................................................67 Figure 40: A model of the principal causes of the crisis ................................................................................69 Figure 41: Producer price of wheat 1991 – 2010 ..........................................................................................73 Figure 42: SAFEX prices of wheat from May 2009 to March 2010 ...............................................................74 Figure 43: The Wheat industry value chain ..................................................................................................76 Figure 44: The market value chain of wheat .................................................................................................81 Figure 45: Porter’s 5 forces model of competition ........................................................................................83 Figure 46: Porter’s diamond .........................................................................................................................86 Figure 47: Business Model Template ...........................................................................................................94 Figure 48: Years of experience of wheat millers .........................................................................................103 Figure 49: Size and scale of wheat millers interviewed ..............................................................................103 vii Figure 50: Years of experience of bakers interviewed ................................................................................105 Figure 51: Scale and size of the bakers interviewed ..................................................................................105 Figure 52: The level of competition perceived by wheat millers and bakers interviewed ............................107 Figure 53: Perceived competition with large scale wheat millers and bakers .............................................108 Figure 54: The impact of input price volatility on the profitability of raw materials. .....................................126 Figure 55: Procurement done on contractual basis ....................................................................................127 Figure 56: The impact of imports and exports on the wheat milling and baking industries .........................128 Figure 57: The perception of turnover over the past five years ...................................................................139 Figure 58: The perceived impact of increases in input costs on milling and baking businesses .................140 viii LIST OF TABLES Table 1: SA Millers’ strengths, weaknesses, opportunities and threats .........................................................22 Table 2: The IDC (2010) SWOT analysis for millers in South Africa. .............................................................25 Table 3: Wheat world estimates for the period 2005/06 to 2009/10 ...............................................................28 Table 4: Regional Wheat Imports from 2005 to 2009 and forecasted up to 2011. .........................................35 Table 5: SADC Wheat Imports and Exports Progress ...................................................................................46 Table 6: The progressive wheat stock levels from February 2009 to February 2010 in ‘000 ton ...................52 Table 7: Average yield (t/ha) of wheat in the RSA per region over 2009/2010* period ..................................55 Table 8: Import parity of wheat (VAT excluded) on 18 March 2010 ...............................................................62 Table 9: Export parity of wheat on 18 March 2010 ........................................................................................65 Table 10: Historical volatility of the wheat contract traded on CME (percentage) .......................................70 Table 11: Historical volatility of the wheat contract traded on SAFEX (percentage) ....................................71 Table 12: Share trends of the various nodes in the retail price of bread .....................................................78 Table 13: Monthly wheat milling in tons .......................................................................................................82 Table 14: The strength areas of the wheat millers and bakers businesses as interviewed. ......................110 Table 15: The weak areas of the wheat millers and bakers businesses as interviewed ............................112 Table 16: Wheat milling and baking opportunities as identified by the interviewees .................................115 Table 17: Threats in the wheat milling and baking industries ....................................................................116 Table 18: The critical areas of a wheat milling and baking business as identified by the interviewees......117 Table 19: The ten most important issues/constraints/challenges currently being experienced by wheat millers and bakers. ....................................................................................................................120 Table 20: Barriers to entry for the wheat milling and baking industries. ....................................................123 Table 21: Risks at a Macro level ...............................................................................................................129 Table 22: Risks at micro level ....................................................................................................................132 Table 23: Legal framework of the wheat milling and baking industry ........................................................135 ix EXECUTIVE SUMMARY The main purpose of the study was to identify factors that restrict development in the wheat milling and baking industry in rural areas of South Africa. In order to conduct a study that adds value to stake-holders within these industries, various objectives were identified. These objectives served as guidelines in identifying factors that restrict development in these industries. An effort was made to as far as possible; discuss these objectives and the results obtained from the study. The objectives of the study therefore can be summarised as follows: 1. Report on previous studies conducted in South Africa on the wheat milling and agro-processing industry. 2. Analyse the wheat supply chain to understand the shorter and longer term issues in the sub-sector that influence the effective establishment of agro-processing industries in rural areas. 3. To unpack the governance/business models of successful smaller mills; looking specifically at contractual arrangements, hedging, infrastructure, and marketing strategies. 4. Identify the critical success factors of the current wheat millers. 5. Analyse the barriers to entry and barriers to exit. 6. Determine the impact of imports and exports of raw materials as well as the manufactured products. 7. Determine the impact of input price volatility on the profit margins of the smaller commercial mills 8. Identify the use of any risk mitigation strategies such as hedging, storage and branding applied by the smaller commercial mills. 9. Identify factors that restrict and/or enhance the competitiveness and profitability of smaller commercial mills. 10. Analyse whether the current support measures provided by the DTI are applicable to the agro- processing sector and to make recommendations on how such support measures can be adapted if needed. 11. Establish protocols within support structures that can assist in the development and sustainability of agro-processing industries in rural areas. 12. Make recommendations on key issues identified in the study. From the outset of the study it was eminent that finding wheat millers and bakers who were willing to take part in the study and if they could provide the study with accurate data would be difficult and of concern. Originally, the study was bound to the geographical areas of the North West and Free State provinces. However, due to the investigation by the Competition Commission and the industries unwillingness to share information, the study was forced to go beyond these boundaries. The problem of information sharing within these industries was also of a concern for the Department of Health. In a study by the Department of Health (2007), where it was mentioned that finding small millers was difficult as the small scale millers did not want to be found, and x